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The Sensex has recovered 650 of the 1,625 points it lost on 24 August, but the ferocity of the crash has badly damaged investor sentiment. The weakness in the stock market had started in the previous week itself, when the Sensex lost 324 points on 20 August and 242 points on 21 August. But the 5.94% fall in the Sensex on Manic Monday has raised a big question in the minds of investors: was this merely a correction in the bull market or the beginning of a bear phase?

We reached out to market experts to know the answers. Most of them feel that the bull market is intact and investors should not get worried by the volatility. “This is a bull market correction and not starting of a bear market,” says Krishna Kumar, CIO, Sundaram Mutual Fund. Others don’t see a significant downside from the current levels. “Since the market has already corrected significantly, the downside is limited,” contends A. Balasubrahmanian, CEO, Birla Sunlife Mutual Fund.

Most experts agree that Indian equities will generate good returns in the long term. However, some of them expect things to get worse before they get better. “We are negative in the short term and expect a further drop of about 5%. 7,400 on Nifty will be a better level to get in,” says Jaspreet Singh Arora, Senior VP, Systematix Shares & Stocks. So, it will be a while before the markets are able to cross their previous highs. “The upside to the market in the next six months is severely limited, so there is no hurry to buy,” says Anand Tandon, market expert.

Citical events lined up

Investors should be mindful of some critical events that are lined up in the coming month. The US Fed will decide on interest rates in September. The RBI will also have its review meeting in the first week of the month. The industry is clamouring for a rate cut and the RBI may finally give in. “Our belief is that the US Fed may get into the rate hike cycle only in November. The RBI may cut interest rates by 25 bps in September and another 25 bps in December,” says Balasubrahmanian.

Despite these positive expectations, FIIs are feeling disillusioned. FII outflows have been quite heavy in the past one month and this trend may continue in the short-term till there is some clarity at the global level. “We expect capital flows to India to stall till the global markets see signs of stability,” says Ritesh Jain, CIO, Tata Mutual Fund.

Though the fundamentals of the Indian market are much better compared to 2013, FIIs are not enthused. Since FIIs count their profits in dollar terms, the continued rupee weakness has dampened their sentiment. The dollar has appreciated 44% against the Indian rupee in the past five years (see chart). This means gains they made in rupee terms have been negated by the rise in the dollar.

Even after the recent cut, the Sensex is still up by around 7,500 points compared to five years back, an absolute gain of 44% for domestic investors. However, foreign investors have not been so lucky. The Dollex 30 was at 3,275 on 28 August compared to 3,194 five years back. Why should FIIs pump in more money when they are not able to generate any returns even after five years? “For FIIs this is not a bull market, but a bear market rally,” says Shankar Sharma, Vice-Chairman and Joint Managing Director, First Global.

The Dollex 30 is now at 3,275, 25% lower than its all-time peak of 4,365 in January 2007. However, the domestic institutions are slowly emerging as a counter force. Indian investors have started putting in money in a falling market, which has provided stability to the market. “Equity mutual funds collected around `2,200 crore on 24-25 August.

This shows the resilience of the Indian market. The situation used to be completely different when markets crashed earlier,” says Balasubrahmanian.

Will the rupee continue to depreciate against the greenback? “Since all fundamental factors are in good shape now compared to 2013, we are maintaining our March 2016 target of Rs 65.5 per dollar. Though the rupee may weaken in the middle due to sentimental factors, the movement will be restricted to the Rs 66-67 range,” says Suvodeep Rakshit, Economist, Kotak Institutional Equities.

However, all experts don’t share this view. Corporate earnings disappoint The biggest risk to the equity markets, however, comes from the slowdown in the corporate earnings. Though the equity market zoomed after the 2014 election results on the hopes of acche din, the corporate results have not kept pace, creating a mismatch between the valuations and earnings growth. The aggregate net profit grew by only 3% in the June quarter (see table). “The present correction is also due to the mismatch between the valuation and the earnings growth. The March quarter was bad and the growth in the June quarter was also meagre. Big earnings growth may not happen during 2015-16,” says Vetri Subramaniam, CIO, Religare Invesco Mutual Fund.

The only saving grace is that the Sensex PE is now only 10% higher than its 10-year average of 19.17 compared to around 25% in the first quarter. In fact, the crash on 24 August had brought down the Sensex PE to 20.37 (less than 7% higher than the long-term average). But the subsequent recovery saw the index PE rise to 21.14 (see chart).

Large caps or mid-caps?

Very few stocks escaped the mauling on Manic Monday. Even so, some mid-cap and small-cap counters witnessed bigger cuts than their large-cap peers.

However, experts contend that the time has not yet come for investors to get in these scrips. The recent correction is very small compared to the rally these stocks have witnessed in the past two years. While the BSE Mid-cap index has almost doubled in the past two years, the Sensex has risen only 42%. Though the valuation premium of the mid-cap segment has come down after the recent crash, it continues to quote at a premium. This is against the historical pattern of mid-caps quoting at a discount to large-cap stocks. So investors need to be extra careful here.

For small investors, the mutual fund route is the best way to invest in stocks. They should not let volatility come in the way of their long-term investment plans. If anything, a crash should be seen as an opportunity to buy more units at lower prices.

But don’t let this greed for more extend to stocks. Some stocks might have become penny stocks after the crash, but don’t be tempted to buy. It doesn’t take long for a stock to touch a two-year low or even a five-year low.

Sectors to bet on

With a free fall in price, the entire commodity segment is in a really bad shape now. The Bloomberg Commodity Index has gone below its 2003 bottom and is already placed at the 16-year low (see chart). Though this kind of crash is good for commodity consumers, it is a red flag for stock investors. A downturn in commodities hints at a global economic recession.

Most of the companies in the commodities sectors had taken huge debts to increase capacity in the heydays. They are now paying the price for being too ambitious.

The expected economic revival along with the fall in interest rates should help the rate sensitive sectors. However, most of the banks have high exposure to troubled sectors like metals. Since most public sector banks have high exposure to metals, it is better to avoid them for the time being. “We like retail focussed private sector banks,” says Balasubrahmanian of Birla Sunlife Mutual Fund.

Some companies that were quoting at higher valuations have become investible after the recent corrections. “Value has emerged in several stocks in private banks and automobile sectors. We like Axis Bank, ICICI Bank and Bajaj Auto after the recent sharp correction in their stock prices,” says Sanjeev Prasad, Senior Executive Director & Co-Head, Kotak Institutional Equities.

Only a few sectors have come unscathed from the recent crisis and IT is one of them. “In addition to the recent rupee depreciation, the US economic revival should also help IT sector companies,” says Saravana Kumar, Chief Investment Officer- Equity & Debt, LIC Nomura Mutual Fund. Investors can continue to bet on frontline IT stocks like Infosys and TCS. Pharma is another sector that will benefit for the same reasons. And then there are several small export oriented sectors like textiles, leather, etc that will benefit from the currency depreciation. “We like Mayur Uniquoters from the leather sector,” says Arora of Systematix Shares & Stocks.

Sectors like FMCG should benefit from the fall in commodity prices. But they are still quoting at high valuation even after the recent mayhem. “Stocks in the consumer sector are still trading at expensive valuations even after the recent correction,” says Prasad of Kotak Institutional Equities. Some of these ‘consumption theme’ stocks will also take a hit due to the fall in rural consumption demand and faltering monsoon.